Financial Instability: Is the U.K. the Next Greece?

Includes: EWU, FXB
by: Peter Cooper

The inconclusive result of the British General Election leaves the UK open to a Greek style financial meltdown next week with the independent pound proving a magnet for speculators and the cost of government debt set to surge, raising interest rates.

The UK stock market fell sharply on Friday as the non-result became clear, and the pound tumbled. But this situation is likely to worsen as the political impasse is not going to be easily solved, and whatever happens necessary austerity measures to reduce the UK deficits will now be watered down.

Is Clegg a king?

The king maker is now Nick Clegg, leader of the Liberal Democrats. However, this is a rather anarchic party of protest and its king is king only in name. That will become a problem as Mr Clegg tries to steer his party into a coalition.

They met yesterday to consider their position. On the table was an offer from the Conservative Party to support them in a minority government. Whatever Mr Clegg thinks it is unlikely he can deliver his party into the hands of Mr Cameron.

The Conservative position on electoral reform, Europe and foreign policy is alien to the Liberal Democrats quite apart from their aversion to big government spending cuts. Then again they are going to have a big problem supporting a government that has just clearly lost the election with the most unpopular Prime Minister in recent history.

The horse-trading required to square this circle is going to take some time, and the outcome is uncertain. If Gordon Brown could be persuaded to take an honourable retirement in favour of somebody acceptable to the Liberal Democrats, perhaps Lord Mandelson, a senior figure and supporter of Europe and electoral reform, then a deal might be done.

But if Gordon Brown does not want to go then this is a problem because it is very hard under Labour Party rules to dislodge a leader. He says he will work to secure the future of the country but has never previously shown much inclination to include his own future into this bargain.

Austerity out, crisis in

Whatever happens the UK is not going to be able to deliver the kind of austerity package that financial markets require to support the bloated debt levels that the UK has run up with its super-high house prices and post-financial crisis emergency spending.

A sell-off and financial crisis therefore looks inevitable this week. Those hedge funds now shorting the euro on the back of the Greek crisis will turn to British financial markets for their next no-lose bets. Shorting sterling is a no-lose, so too must be the FTSE stock market that is priced in sterling.

The UK is about to feel the full impact of the downside of having an independent currency, namely a stampede for the exit door with no Germanic cousins in the wings with a bailout package. Besides the UK economy is much bigger than Greece, so a bailout is far more difficult to arrange.

The IMF is waiting for a call from the next UK Prime Minister. But who is he? Markets will make it perfectly clear that they do not back a country without one.

Disclosure: No positions

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